The Complex Linkage Between Commodities and Producer Prices
Higher commodity prices don't necessarily lead to higher inflation; a combination of external factors lead to both higher commodity and producer prices simultaneously and asymmetrically.
Commodities and Inflation
I have puzzled for years why commodities are considered to be an indicator of inflation and vice-versa. At best, I can understand it via my "handful of dirt" hypothesis: If expected inflation is 5% and short-term holding costs are 3%, I will gain just under 2% per annum in nominal gains for any tangible asset, a handful of dirt included.
Yes, both first great commodity outbursts of the 1970s followed rising inflation, the operative word being "followed," but that belies a much larger truth. If we map the CRB Index (now the ThomReuters/Jefferies CRB Index) led one month against the Producer Price Index going all the way back to the CRB's inception in September 1956, we can identify two very long periods of negative correlation, both marked with rectangles. During the September 1956-November 1971 period, the CRB declined at an average annual rate of 0.6% while the PPI rose 1.68%; during the November 1980-October 2001 period, the rates were -2.73% and 1.96%, respectively.
These combined periods of negative correlation of returns represent more than 65% of the available history, and yet the simple amongst us assume they rise and fall together. Yikes.
Leads and Lags
A statistical test for causation, Granger analysis, reveals a one-month leading relationship between the CRB and the PPI; it also reveals a much stronger contemporaneous relationship. This is somewhat perplexing; the CRB is measured from futures prices, not from current cash market prices, and therefore should be unable to affect the PPI either immediately or even after a one-month lag. However, 55 years of data are 55 years of data, and arguing with the facts has seldom proved fruitful for me.
What we are left with is a long-term history where long periods of negative correlation between the CRB and PPI alternate with simultaneous bursts to the upside where both indices rise sharply. Only one period, the immediate aftermath of the 2008 financial crisis, had positive correlation with declining index levels.
This suggests both indices are affected more by a common factor or set of factors such as monetary policy shocks or supply shocks that produce the observed simultaneous increases. The 2008 period has an obvious demand shock to explain things. The fairer conclusion is not "higher commodity prices lead to higher inflation," but rather "a combination of external factors lead to both higher commodity and producer prices in a simultaneous and asymmetric fashion."
Lasting through the end of March, 100% of the donations made to The Ruby Peck Foundation for Children's Education will be channeled to the children of Japan as they attempt to find their footing following this natural disaster; and to kick off this drive, we'll pledge $5000 to get it started. Please do what you can, as it will add up, and thanks.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.